Risk management tips from Tullett Prebon compliance failures

Tullett Prebon (now part of TP ICAP) is an electronic and voice inter-dealer broker acting for institutional clients transacting in wholesale financial markets, typically investment banks. According to the FCA, the rates division of Tullett Prebon (Europe) Limited (TPEL) carried out “name passing” broking, which comprised a significant part of Tullett Prebon’s overall business, employing many brokers and generating significant revenues for the firm.

The FCA found Tullett Prebon’s rates division for several years had deficient controls around broker conduct. Lavish entertainment and a lack of effective controls allowed improper trading to take place, including “wash” trades, which involve a set of two identical swaps trades between the same two counterparties. The second trade is the equal and opposite of the first trade, thereby cancelling out the first trade so neither counterparty has any exposure or credit risk. “Both trades are a sham and have as their sole purpose the generation of brokerage,” the FCA said.

In Tullett Prebon’s case, 17 wash trades were arranged in the name of passing business of the Rates Division of TPEL between September 2008 and October 2010. The total brokerage generated for TPEL by these 17 wash trades was over £314,000 (U.S. $404,000).

“Senior management and compliance were cocooned from seeing the misconduct, and systems and controls failed to probe broker conduct, even when warning signs were visible,” said Mark Steward, the FCA’s executive director of enforcement and market oversight. “The case against Tullett Prebon was a long and complex one. The firm’s failure to be open with the FCA about the existence of key evidence reflected a high degree of culpable incompetence and prejudiced the FCA enquiries.”

Risk management lessons

The case imparts the following lessons in both compliance and risk management:

Do not ignore red flags. Principle 2 of the FCA’s Principles for Businesses requires a firm to conduct its business with due skill, care, and diligence. “Senior managers at TPEL failed to act with due skill, care, and diligence when they were faced with blatant signals of broker misconduct,” the FCA said in its Final Notice.

“Rather than taking steps to address the risk presented, they took no action,” the FCA said. “For example, when significantly high brokerage was generated on a trade and a senior manager asked the broker responsible if it was an error, the broker confirmed it was correct and told him ‘you don’t want to know.’ No steps were taken to explore the obvious risk of broker misconduct.”

“The case against Tullett Prebon was a long and complex one. The firm’s failure to be open with the FCA about the existence of key evidence reflected a high degree of culpable incompetence and prejudiced the FCA enquiries.”

Mark Steward, Executive Director of Enforcement and Market Oversight, FCA

Compliance functions have a monitoring role. In Tullett Prebon’s case, the compliance department did carry out trade monitoring in relation to non-market price transactions for matched principal trades but did not engage in monitoring of any kind concerning the name passing business. Checks and balances that were supposed to be done by the compliance department were not done. “The compliance department failed to act with due skill, care, and diligence as it assumed certain controls around broker conduct were being operated within the name passing business when in fact such controls were not being effectively used in practice,” the FCA said.

“The decision that the compliance department should not carry out any monitoring in the name passing business in the rates division was initiated within the compliance department and approved by an executive director of the Tullett Group,” the FCA said. “This decision was taken on the basis that the risk of market abuse was TPEL’s key area of focus and the matched principal desks were considered a higher risk area in this regard.”

Make sure to implement adequate systems and controls. Principle 3 of the Authority’s Principles for Businesses requires firms to take reasonable care to organize and control its affairs responsibly and effectively, with adequate risk management systems. In Tullett Prebon’s case, “adequate systems and controls should have been in place and effectively implemented within the Rates Division to counter the risks arising from the conduct of brokers,” the FCA said.

“While certain systems and processes were available and could have been utilized to address the risk of broker misconduct, they were not used for monitoring and compliance purposes,” the FCA said. “There was a disconnect between the potential use of such systems and controls to reduce the risk of broker misconduct and the practical reality of what was happening within the business.”

“While the compliance department and the Tullett Group executive committee thought certain systems and controls around broker conduct were effective within the name passing business, in practice these systems and controls were not effective,” the FCA said. “The focus of the name passing business in the Rates Division was instead almost exclusively on revenue generation.”

The FCA said it considers these breaches of Principle 2 and Principle 3 to be “serious,” and that “it is likely that some of the trading which generated unwarranted brokerage for TPEL would either have been prevented or would have been identified and stopped were it not for these breaches of Principle 2 and Principle 3.”

Cooperation counts. According to the FCA, Tullett Prebon also breached Principle 11 of the FCA’s Principles for Businesses by failing to be open and cooperative with the FCA. This breach occurred between August 2011 and October 2014 and related to the FCA’s request to Tullett Prebon in August 2011 for broker audio tapes.

Although Tullett Prebon had the majority of the audio the FCA required, they failed to produce the audio to the FCA until 2014. Tullett Prebon initially provided an incorrect account as to how the audio had been discovered.

The FCA said this breach, too, is serious. “Principle 11 is a fundamental plank of the operation of the regulatory system,” the FCA said. “Part of that depends on firms complying with information requirements and accurate information being given to the FCA.”

Tullett Prebon agreed to resolve this matter and, therefore, qualified for a 30 percent discount under the FCA’s settlement discount scheme. Without this discount, the fine would have been £22 million (U.S. $28 million).